Recent Posts

Another week, another step closer to financial Armageddon.
President Obama spent the weekend trying to impress upon a
skeptical public the wild notion that a
default on U.S. debt could ruin their summer.

Senators from both sides of the aisle took to the Sunday talk
shows, only to paint themselves deeper into their respective
corners. And Michele Bachmann expanded her franchise
of fractured science, venturing into economics to assure her
public that an American government rendered unable to pay its
bills is no big deal.

And Wall Street is…okay with this?

True, financial services CEOs such as Citigroup’s Vikram Pandit and BlackRock’s Lawrence Fink
were among the 470 corporate Pooh-Bahs who signed a Business
Roundtable letter last week urging Washington to avoid
default. And many
Wall Street trade groups have issued antiseptic statements
that say, in effect: “We respectfully urge our elected officials
not to visit financial calamity on the world.”

But really, folks, that’s not just no bite--it’s no bark. Compare
Wall Street’s oddly passive stance on the debt ceiling with the
treasure it has
expended fighting regulatory reform. You’d think it was
Elizabeth Warren who was threatening to default on $14
trillion and plunge the world into a second global crisis. And
then there is the market. As politicians took turns delivering
ultimatums and stomping out of meetings (or not), the yield on
the benchmark 10-year Treasury bond actually fell slightly to
2.9%. Compare that with the 18% yield on comparable
Greek government bonds, another country with a famous debt
problem.

There are only two possibilities: Either Wall Street knows
something the rest of us don’t, or Wall Street is in denial.

Wall Street Knows Something

Based on the lousy job financiers did anticipating the 2008
financial crisis, we can rule out the idea that the Street
actually knows the future. What it does know is what everyone
else on the Street is saying about the future. And what they’re
saying is that the
debt ceiling will be raised.

When asked why the Street isn’t more worried, Brian Salisbury,
senior policy analyst for FBR Capital says, “Because for the past
six months they’ve been listening to people like me tell them
that everything will be okay.”

What makes analysts like Salisbury so sure? Logic, for one thing.
“However we got here, and however we're going to get out of it in
the long run,” David Kelly of JP Morgan told Barron’s, “the debt is too large
to go to zero overnight, and therefore it's simply untenable to
say that you are not going to raise the debt ceiling. No serious
politician should say that.”

Anyone who understands finance knows that a default would send
the U.S. back into recession, which would only widen the deficit.
They know it makes no sense to vote to extend the Bush tax cuts
in December and thereby accelerate the need to raise the debt
ceiling, then seven months later to vote against raising it.

Most of all, Wall Street sees the debt ceiling debate as mere
political theater, which, by the way, House Speaker John Boehner has promised will have a happy
ending. Because Armageddon can be avoided, and because avoiding
it is in everyone’s interest, logic suggests it will be avoided.
That frees financial executives and traders to focus on issues
that really will affect their profits: earnings season, new
regulation, and Greek debt. As
Grant’s Interest Rate Observer editor Jim Grant puts it, “The
talks in Washington, DC, over the debt ceiling, we regard as
political posturing. Not so the [Greek mess]. Now there is a
crisis.”

Wall Street Is in Denial

But suppose that logic is not the most relevant attribute here?
Boehner may understand the need to avoid financial calamity, but
it’s not clear that he controls the GOP’s junior members. For
them, there is too much political thrill to be gained by racing
still closer to the edge of the cliff before jumping out of the
car. Indeed, some 90 of them, according to
Salisbury, have declared their willingness to drive over the
cliff rather than vote for tax increases.

Some analysts are starting to warn the financial markets that the
sanest course isn’t necessarily the one Congress will take. Greg
Valliere, chief political strategist at Wall Street consultant
Potomac Research, estimates a 35% chance that there will be no
deal before August 2. Salisbury puts it at 25%.

In that case, Treasury Secretary Tim Geithner will almost certainly ensure that
Treasury bondholders are paid, even if other parts of the
government must be selectively shut down. But here’s the rub: The
credit rating agencies have made it clear that a shutdown will
trigger a
downgrade of U.S. debt. You may or may not respect Standard
& Poor’s and Moody’s, but many institutions’ investment
policies allow them to hold only triple-A-rated securities. It’s
not clear what will happen if they can’t hold U.S. bonds. But
it’s surely not going help bond prices.

If there is no deal by the end of this week, Valliere predicts,
you can expect Wall Street to begin to focus on the issue. Some
on the Street ask whether it will take a stock market crash like
the 700-point downer that followed Congress’s refusal to pass
TARP in 2008 to get Congress to compromise. That’s the last thing
the economy (or Wall Street) needs. It’s time for the big dogs to
start barking.